Market volatility is the new normal. And when markets are volatile, we see volatility in the prices of exchange traded funds (ETFs). Some investors may wonder if the ETF is simply showing us the market volatility, or if it is actually causing it. Let’s take a closer look.
We know that ETFs trade on the open market. Let’s pretend that we’re monitoring an ETF that is listed in the US but invests in Asian stocks. If we buy that ETF and keep an eye on its price when the Asian market is closed, we can see that the price of the ETF still moves throughout the day, even though the Asian market is closed. That’s because news and information in the U.S. and European markets impacts the value of Asian market stocks, and thus the ETF that holds those stocks.
When the Asian market opens again, we see the local stocks move to reflect this new information, and the ETF’s price realigns with the local market. We call this “price discovery”—the ETF is showing you where the market should be priced at a given point in time, even if that market is closed. If all markets are open at the same time, this form of price discovery generally doesn’t take place.
ETFs and Market Volatility
ETFs by nature have created entries into the market that investors wouldn’t normally have otherwise. Some speculate that now more investors have access to markets, there is more trading, and this can actually cause market volatility. We’ve done a lot of research on this and found that ETFs do not cause market volatility. Instead, their price fluctuation is simply exposing already-existing market volatility, adding transparency to the ETF’s price fluctuations.[related_stories]